Q. “An agreement in Restraint of Trade is Void.” Explain this principle with its exceptions, if any.


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The provisions related to restraint of trade are given under section 27 of Indian contract act, 1872 (here and after ICA). It provides that any agreement that prohibits one person from starting or continuing his trade, business or profession, in return for some consideration is void.

This section seeks to ensure effective exercise of one's right to carryon any lawful profession, trade or any kind of business without any restraint thereon. The principle on which this section is based is in consonance with Article 19 and part 13 of the Constitution of India.

An agreement will be void under section 27, if the following conditions are satisfied-

(i)     Existence of an agreement,

(ii)   The same must restricts the parties from pursuing a profession, trade, business of any kind.

(iii)   Profession, trade, business sought to be restricted must be lawful.

(iv)  The restriction sought to be imposed do not cover any exceptions under section 27 or any other exception recognised under any existing law.


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Exception mentioned under Contract Act

Section 27 of the Act mentions only one exception validating restraint of trade, i.e., Sale of Goodwill (An intangible asset of the firm). however, this is subject to certain conditions:

(i)     restrain must be within specified local limits,

(ii)      restraint must be for the period as long as the buyer or any person deriving title carries on the business.

(iii)      limits of restraint must appear to the court reasonable regard to the nature of the business.


Exceptions mentioned under Partnership act

The Act lays down three exceptions. These are:

I.                     Mutual agreement with the partner: An agreement with a partner of the firm to not carry out his own business so long as he/she is a partner in the said firm will be valid under Section 11 (2) of the Partnership Act.

II.                   Cessation of the partnership: Section 36 of the Act provides that when a partner ceases to be a partner in a firm, even after getting his accounts settled, he is required, not to carry out a similar business for a specified period or within specified local limits, in order to protect the interest of other partners.

III.                  Dissolution of the firm: At the time of firm’s dissolution, some of the partners may conclude an agreement from other partners agreeing not to conduct a similar business for a specified period or within specified territorial limits. As per Section 54, such agreements are valid.


Exceptions recognized through judicial interpretations

I.                     Restraint by a contract of service: An agreement whereby an employee covenants to bind himself not to compete his employer during the term of his agreement, is not a restraint of trade, but rather can be called as terms of the service.

II.                   Trade Combinations: The primary object of such association is to regulate business and not to restrain it. Hence, it is allowed under contract law.


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Important Cases

Madhub Chander v. Raj Coomar Dass: In this case, the parties were businessmen in Calcutta. The defendant, Rajcoomar suffered loss due to the plaintiff’s competition and entered into an agreement with the plaintiff that if he closed his business there, he would pay him all the advances he had made to his workmen. When the defendant failed to pay, the plaintiff filed a suit to recover the amount but failed to do so because it was an agreement in restraint of trade, therefore not enforceable in a court of law.

Firm Daulat Ram vs. Firm Dharm Chand: In this case, two similar business owners, in a partnership, came to an agreement that only one of their factories would work at a time and the profit will be shared between them. This restraint was held to be valid.

Chandra v. Parsullah: In this case, the plaintiff was the owner of a fleet of buses that used to ply between Pune and Mahabaleshwar. The defendant also had a similar business in the same area. To avoid competition, the plaintiff bought the defendant’s business along with the goodwill, and by contract made him agree not to open a similar business in the area for 3 years. The defendant did not comply and started his business.

It was held by the court that the agreement was valid, as it fell within the exception to section 27 of ICA.

Charlesworth v. Mc Donald: The defendant agreed to serve as an assistant to the plaintiff, a physician and a surgeon at Zanzibar, for a period of three years and not to practice himself during that period. After one year, he left the plaintiff's service and started his own practice in Zanzibar. It was held that the plaintiff was entitled to restrain the defendant from practicing during the period of agreement in Zanzibar.


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